Wall Street’s Love Affair with Apple May Be Over

Justin Sullivan / Getty23 Jul 2015Newport Beach, CA

In its last quarter that will be impacted by innovation on Steve Jobs’ watch, Apple booked strong quarterly revenue and earnings this week. But the company had to admit that existing Apple customers were slow to upgrade to new iPhone releases, and Apple as a status symbol in China may be coming to an end.

Apple stock traded up yesterday to near its February all-time-high of $133 per share in anticipation of record earnings for its third fiscal quarter ending June. The company did not disappoint. Profit soared to $10.7 billion, or $1.85 a share, on revenue of $49.6 billion; compared with $1.40 a share on $37.4 billion in quarterly revenue a year earlier.

Apple has continually had more “cash on hand” than any other country on the planet for the last three years running. That number swelled to $202.8 billion over the last three months. The company now holds the twelfth-largest warchest by total assets (including inventory, accounts receivable, and property), at $273 billion.

The bad news for Apple is that the upgrade of the iPhone’s installed user base to the new iPhone 6 and iPhone 6 Plus was only about 20 percent, almost a third lower than previous cycles after two quarters. It would appear that the Apple iOS ecosystem is being challenged, and that most of the sales momentum over the past two quarters was driven by new demand taking market share from other competitors rather than iPhone owners’ replacement demand.

The key to Apple’s business “comparable advantage” has been that existing Apple smartphone owners in its ecosphere will dutifully follow all iOS upgrades. The low internal conversion rate may mean that Apple consumers do not see enough innovation to justify upgrading, or the $700 average price point has become a competitive limitation. That suggests that Apple will soon need to defend its customer base by cutting prices and accepting lower profit margins.

China had a spectacular stock market boom over the last year that saw prices jump by 150 percent through the middle of June. Since late 2013, the number of Chinese stock brokerage accounts for small individual investors exploded from 20 million to about 100 million. Carrying an iPhone to check stock quotes was seen as the ultimate “Yuppie” statement for the “nouveau riche” Chinese.

That type of instant riches creates what economists call a “virtuous wealth effect,” which encouraged 100 million Chinese stock investors to dramatically increase their consumer spending as their assets appreciated. For the three months ending in May, Apple’s smartphone unit sales in China were up by a stunning 46.26 percent, according to Kantar Worldpanel.

But with Chinese stocks losing about a third of their value since June 14, Breitbart News warned two weeks ago, in “Apple iPhone Implodes in China Stock Crash” that Chinese consumption would suffer a huge “negative wealth effect” as over-consuming Chinese hit the brakes on spending. As the biggest consumer products winner during China’s positive wealth effect, the iPhones and newly introduced Apple Watches should be the worst losers as the wealth effect turns negative.

Apple management in its first post-Steve Jobs initiatives is introducing a series of “derivative services” that includes Apple Pay, Apple Music and a soon-to-be-launched Apple Web TV. All of these services are designed to keep Apple users corralled in the iOS ecosystem’s “walled-garden.”

But that strategy is built on an acceptance that mobile hardware and software are not a sustainable high-margin business model, as competing original equipment manufacturers (OEM) like Google, Xiaomi, Huawei and Lenovo continue to close in on Apple’s leadership innovations.

Apple users upgrading to the large screen iPhone 6 Plus “phablet” will further cannibalize iPad shipments. The iPad will continue to remain relevant to mobile business users who need the bigger screen, but consumer iPad demand will wither.

Two-thirds of Wall Street analysts had Apple as a “buy” and there were no “sell” recommendations before the latest earnings report. That explains why Apple’s stock (APPL-NASDAQ) got clobbered in the last 24 hours. The stock should remain under pressure as analysts become more realistic on the company’s longer-term earnings prospects.

Apple management has the cash to acquire almost any company, or maybe even a country or two. But they have failed to demonstrate either willingness or the ability to design and build the type of highly disruptive products that made Steve Jobs a legend and Apple the richest company on earth.